The Volcker Rule

Obama’s economic adviser and his battles over the financial-reform bill.

“It doesn’t have the purity I was searching for,” Paul Volcker says of the new law.Credit Illustration by Finn Graff

On the evening of Wednesday, June 23rd, Paul Volcker, the former chairman of the Federal Reserve, was monitoring events on Capitol Hill from his office, which overlooks the ice-skating rink at Rockefeller Center. Volcker, who is eighty-two years old, works at a polished granite desk covered with correspondence, books, and financial reports. Apart from a slight loss of hearing, he is in robust health, and when he rises to greet guests he towers above them. His height (six feet eight inches) is initially intimidating, but that impression is soon mitigated by his wry manner. For a year and a half, Volcker, who serves as an economic adviser to President Barack Obama, had been waging a campaign to curb greed and speculation on Wall Street. This effort was reaching a climax, as the Senate and the House of Representatives worked to reconcile the lengthy financial-reform bills that each had passed.

Volcker retired from the Fed in 1987, and during the latter years of the tenure of his successor, Alan Greenspan, he was widely regarded as an out-of-touch fuddy-duddy. In the previous six months, however, he had emerged as a de-facto arbitrator for the various factions involved in financial reform: the lobbyists, the politicians, and the public-interest advocates. Barney Frank, the Democratic congressman from Massachusetts, who helped lead the process of reconciling the House and Senate bills, told me in late May, “When the banks come to me opposing various things, I say to them, ‘If I were you, I would go and see Paul Volcker. If you can persuade him, you might have a chance. I think you are not going to see anything in this bill that Paul objects to.’ ”

Frank had set June 25th as the deadline for finishing the bill, and during the final two nights of negotiations Volcker still appeared to be playing the role of esteemed referee. His main goal was to preserve the so-called Volcker rule, which barred banks from speculating in the markets—a practice known as proprietary trading—and from operating and investing in hedge funds and private-equity funds. Volcker believed that if such a policy were effectively enforced it would go a long way toward restoring the legal divide between commercial banking (the issuance of credit to households and firms) and investment banking (issuing and trading securities). That split existed from the Great Depression until the repeal of the Glass-Steagall Act, in 1999. Before the repeal, commercial banks were given government protection in case things went wrong, and investment banks were given freedom to do what they wanted with their money. Afterward, everyone was given the freedom, but it was no longer clear where the government safety net ended.

Volcker believes that commercial banks, such as Citigroup and Wells Fargo, are worthy of receiving government assistance—and even, in extremis, taxpayer bailouts—because firms and consumers depend upon them for credit. In return for these enterprises being sheltered, they should refrain from risky activities such as proprietary trading and sponsoring hedge funds. “If you are going to be a commercial bank, with all the protections that implies, you shouldn’t be doing this stuff,” Volcker said to me. “If you are doing this stuff, you shouldn’t be a commercial bank.”

The financial industry was lobbying vigorously to weaken the Volcker rule. Shortly before dinnertime on Wednesday, a Capitol Hill staffer called Volcker’s chief of staff, Anthony Dowd, a former investment banker, to let him know that Senator Christopher Dodd, the head of the Banking Committee, had released a new compromise proposal. The Democratic leadership needed the vote of Scott Brown, the freshman senator from Massachusetts, who had demanded changes that would please the big financial firms, several of which are based in his state.

Dowd wasn’t immediately alarmed, and Volcker was prepared to make some compromises. Earlier in the month, he had met with a group of bank C.E.O.s and lobbyists. Since then, he had been working with his two closest allies on the Hill, the Democratic senators Jeff Merkley, of Oregon, and Carl Levin, of Michigan, on new language that would preserve the essence of the Volcker rule while allowing the banks some flexibility in how they manage their money. Dodd’s new proposal largely stuck to this framework. In a significant concession, it allowed banks to invest up to three per cent of their capital in hedge funds or private-equity funds. But it included restrictions on this freedom, among them a specific dollar limit on investments.

Dowd assured Volcker that Dodd’s proposal contained no big surprises, and Volcker went out to dinner at the Harvard Club. Dowd called again around ten o’clock to say that things were still going according to plan. But when Volcker reached his office the next morning he learned that Dodd and Frank had agreed overnight to drop some of the restrictions in the compromise proposal, including the dollar limit on hedge-fund investments. “ ‘Shock’ is too strong a word,” Volcker recalled. “But I was disappointed.”

Despite Frank’s prediction, there were now going to be some things in the bill that Volcker objected to. Moreover, Senator Brown was demanding further changes, and the Democratic leadership and the Administration were determined to complete a package that President Obama could present to a G-20 meeting in Toronto on the weekend of June 26th. “I think they had priorities that were a little different from mine,” Volcker told me a few days later. “The President wanted a bill. He was going to Toronto. Everybody wanted a bill. It comes down to a squeeze play, and the sixtieth vote, or the person who’s perceived as the sixtieth vote, he’s got an awful lot of leverage.”

As the deliberations on Capitol Hill extended through the night of June 24th, the financial lobby exacted several more concessions, including a change in the definition of the three-per-cent limit on investments in hedge funds and private-equity funds. To outsiders, the switch in language from “tangible common equity” to “Tier 1 capital” signified nothing. For the banks, it meant that they could increase by up to forty per cent the amount of money put into risky investment vehicles.

On the morning of June 25th, after the negotiating session finally ended, Dodd and Frank described the reform legislation as the broadest and most far-reaching since the nineteen-thirties. Among the many articles contained in its twenty-three hundred pages, there were provisions that establish a new federal bureau to protect consumers against predatory financial companies; force the trading of many types of derivatives onto open exchanges; and give the federal government the power to seize control of stricken non-bank financial companies—a legal authority that had been lacking in the cases of Bear Stearns, Lehman Brothers, and A.I.G. Later in the day, President Obama announced that the bill included ninety per cent of what he had fought for.

Volcker, after a weekend of conspicuous silence, fell in line and issued a statement that the package “provides a constructive legal framework for reform of the financial system.” When I talked to him a day later, however, he said that he had mixed feelings, adding, “We could have done better.” Although the final bill contained many things that he supported, the last-minute weakening of the Volcker rule had confirmed some of his fears about the political process and the power of lobbyists. “The ban on proprietary trading is still there,” he said. “But I’m sorry we lost the tighter limitations on hedge funds and private equity.” He went on, “I’m a little pained that it doesn’t have the purity I was searching for.”

Passage of the Dodd-Frank Bill, which President Obama was expected to sign this week, represented a messy conclusion to a debate about how to deal with the risks created by reckless finance. Since the implosion of Bear Stearns, in the spring of 2008, three broad approaches to reform had emerged. One, associated with the Treasury Department and the Federal Reserve, emphasized the importance of reducing the amount of leverage in the system. For every dollar of capital that investment banks have, they sometimes have twenty or thirty dollars invested in various markets. Raising the amount of cash that the banks are required to hold can help them survive in the event of sudden losses. The second approach, supported by Volcker, was to tightly restrict the risky activities that banks could engage in. The third approach, which was championed by some independent economists, called for breaking up the biggest financial firms. The idea is that no financial firm should be so large, and so connected to the others, that it is too big to be allowed to fail.

The Dodd-Frank legislation is an ungainly hybrid that contains elements of the first two approaches but ignores the third. It orders firms to hold more capital for derivatives trading and other risky business lines—something Volcker supported—but doesn’t say how much. It prohibits proprietary trading but doesn’t explain how the ban will be enforced. And if these restrictions don’t work, and another crisis ensues, it says that stricken firms will be taken over and wound down rather than rescued—another Volcker priority—but it doesn’t rule out the possibility of bailouts. “There is a great amount of ambiguity about how the bill will evolve in practice,” Raghuram Rajan, a University of Chicago professor who was one of the few economists to warn about the risks of a financial blowup, told me. “It has tremendous promise, but also tremendous scope for disappointment.”

Volcker began talking about financial reform in March of 2008, when, as part of the takeover that prevented Bear’s collapse, the Fed agreed to absorb any future losses on some twenty-nine billion dollars’ worth of the firm’s mortgage assets. Volcker remarked publicly that the Fed was operating at the edge of its legal authority. Six months later, Volcker’s unease about bailing out Wall Street speculators resurfaced when, after the collapse of Lehman Brothers and A.I.G., Congress appropriated seven hundred billion dollars to rescue the entire banking system, and the Fed granted commercial-banking licenses to Goldman Sachs and Morgan Stanley, the two largest remaining Wall Street investment banks—thereby giving them access to federal loan guarantees and emergency-lending facilities operated by the Fed. Given the scale of the crisis, Volcker viewed the taxpayer-funded recapitalization of the banking system as unavoidable, but he didn’t like the additional supportive measures for Wall Street firms that were primarily engaged in the business of trading. “When the U.S. government made Goldman and Morgan bank-holding companies, to Volcker that was like the gates of Hell had opened, although he knew it was part of trying to quell the panic,” a senior Administration official recalled.

During the transition between the Bush and the Obama Administrations, Volcker was mentioned as a possible Treasury Secretary. His principal rival for the post, Timothy Geithner, who was the president of the New York Federal Reserve Bank, had helped formulate the policy response to the financial crisis. Volcker told me that he never wanted a full-time job, but some of his friends insist that he could have been persuaded. “He would have taken it on the basis that he wouldn’t necessarily stay for a full four years,” said Michael Bradfield, a former colleague of Volcker’s at the Fed, who is now general counsel to the Federal Deposit Insurance Corporation.

After President Obama made his choice, Volcker expressed his support for Geithner, but tensions lingered. In January, 2009, a group of experts led by Volcker published a report for the Group of Thirty, an organization of senior business executives and academics, which made a number of recommendations, including one that stated, “Large, systemically important banking institutions should be restricted in undertaking proprietary activities that represent particularly high risks and serious conflicts of interest.” In June, the President’s Economic Recovery Advisory Board, the group of business executives and economists that Volcker heads, sent the White House a four-page document supporting a ban on proprietary trading by banks, which involves their bets on the directions of interest rates, currency movements, and securities prices. In recent years, many big financial firms have expanded their “prop desks,” which can generate huge profits but also significant losses. At Goldman Sachs, proprietary trading accounts for about ten per cent of the firm’s revenues.

The Treasury published a white paper on financial reform later that month, but made no mention of banning proprietary trading, or of stopping banks from investing in hedge funds. It said that any financial firm that posed a potential threat to the system would have to raise more capital and hold more money in reserve against possible losses. As long as it did this, it would be allowed to take risks as it saw fit. These firms would be subject to one set of regulations, and a legal mechanism would be set up to enable them to be safely wound down in a crisis. When the white paper was published, the Treasury Department asked Volcker to go to Washington for the press conference. He refused. “What am I supposed to do if a reporter asks me if I agree with everything in it?” he asked a colleague. “Say, ‘No I don’t’?”

Volcker insisted to me that he gets on fine with Geithner and that the differences between them came down to competing philosophies. After the demise of Lehman (an investment bank) and of A.I.G. (an insurance company) brought the entire banking system to the edge of collapse, many policymakers concluded that the labels attached to big financial firms didn’t matter much anymore: once they reached a certain size and level of interconnectedness with other firms, they were too big to be allowed to fail. With all of them regulated in the same manner, imposing capital requirements would be a better way to prevent excessive risk-taking than prohibiting proprietary trading, which is sometimes difficult to distinguish from other types of trading. Geithner held this view, as did Lawrence Summers, the director of the White House’s National Economic Council.

Many independent analysts agreed, arguing that Bear and Lehman had been destroyed by excessive borrowing and by their sunny view of the subprime-mortgage market. Their proprietary-trading desks had not been the problem. Benn Steil, an economist at the Council on Foreign Relations, told me that, if bank deposit insurance didn’t exist, he would consider an investment with Goldman’s prop-trading desk safer than one with a Midwestern bank that would turn around and lend it to local businesses. If Volcker’s recommendations had been in effect before 2008, Steil said, “the crisis would have unfolded precisely as it did.”

Volcker countered that the Treasury’s approach risked exacerbating the likelihood of future bailouts. In proposing to grant the biggest financial firms special legal status as “Tier 1 financial holding companies,” the Treasury came close to designating them as too big to fail, thereby encouraging them to take more risks. He much preferred the older idea of limiting government assistance to commercial banks that don’t engage in speculative activities. Such a policy necessarily involved drawing a clear distinction between them and other financial institutions, and that was what a ban on proprietary trading would do. “If we are going to put ‘too big to fail’ back in the bottle, the first question is: Whom are we going to protect?” Anthony Dowd explained. “The answer is: We are going to protect the banks. The second question is: What is a bank? The Volcker rule is a way of defining that, and it doesn’t include speculative activities. Why should the government protect those?”

During the summer and fall of 2009, Volcker continued to push his ideas, but he didn’t appear to be getting far. When he testified before the House Financial Services Committee, in September, there were many empty chairs. In October, the Times published a front-page story about his lack of clout in the Administration and quoted him saying, “I did not have influence to start with.”

Volcker’s skepticism about bankers and other financiers dates back to his days at the Fed, where he opposed the Reagan Administration’s efforts to deregulate the banking system. In 1982, Congress passed the Garn-St. Germain Depository Institutions Act, which gave struggling thrift banks (also known as savings and loans) the right to make commercial loans. (Previously, they had been restricted to residential lending.) The legislation was intended to enable thrifts to earn higher profits, and it was strongly supported by Treasury Secretary Donald Regan, the former head of Merrill Lynch. Volcker repeatedly disagreed with Regan and with other members of the Administration. Referring to the S. & L.s, he told his staff, “Give ’em commercial lending power, and they’ll end up with all the bad loans.”

This is precisely what happened, and Volcker regards the S. & L. crisis, which ended up costing taxpayers about a hundred and eighty billion dollars in today’s money, as a template for the financial catastrophe of 2007-08. Unlike many economists, who regard financial innovation as generally a good thing, he is suspicious of many things that today’s big financial institutions do, such as creating complex securities and building elaborate mathematical models. Last December, at a conference in England for banking executives, he said that the most important banking innovation of recent decades was the A.T.M.

Volcker is driven by a sense of moral urgency. For years, financiers motivated by the prospect of short-term gains—traders, investment bankers, quantitative analysts, hedge-fund and private-equity-fund managers—have been extracting outsized monetary rewards, while insisting that they earned them by creating wealth for their clients and making markets more efficient. Then came the crisis of 2007-08, in which misguided financial engineering brought down the entire economy. Speaking to the conference in December, Volcker said, “Wake up, gentlemen. Your response, I can only say, has been inadequate.” In an era accustomed to the circumlocutions of Alan Greenspan and the anodyne public statements of Ben Bernanke, the chairman of the Federal Reserve, Volcker’s outspokenness insured that his statements were widely noticed. “He’s got a well-defined view of finance that is very refreshing,” notes Austan Goolsbee, a University of Chicago professor who is the chief economist of the White House advisory board that Volcker chairs. “He says, ‘You’ve gotta keep an eye on these guys. If you give them the chance, they will use their market position to line their pockets.’ That’s an important world view.”

It’s also an attitude that Volcker extends to his family. A few years ago, Volcker’s eldest grandson, who is a math whiz, informed him that on graduating from college he was planning to become a financial engineer. “My heart sank,” Volcker told me. (After working for a couple of years on Wall Street, the young man has now moved on, much to Volcker’s relief.)

Ultimately, it was Wall Street’s recidivist tendencies that put new life into Volcker’s reform campaign. By the end of 2009, firms that had been bailed out a year earlier were making hefty profits and setting aside big bonuses. Goldman Sachs, for example, granted its employees a total of sixteen billion dollars in compensation and benefits. The public was furious, and people were demanding that the profits and bonuses be taxed. But the Treasury Department was refusing to support those ideas. Inside the White House, the President’s political advisers were alarmed by the growing populist backlash. So was Vice-President Joseph Biden, who expressed support for Volcker’s ideas, which had picked up endorsements from a number of veteran financiers. Michael Bradfield, of the F.D.I.C., telephoned Volcker and said, “You should call Biden.” Volcker took Bradfield’s advice. Shortly after that, Jared Bernstein, Biden’s economic adviser, contacted Anthony Dowd and asked for details of Volcker’s reform proposals. Dowd wrote memos explaining what a ban on bank proprietary trading would mean and how such a policy could be worked into the Administration’s existing reform plans.

The White House invited Volcker to come down for a meeting. On Christmas Eve, he had a long working lunch in the West Wing with Geithner and Summers, both of whom sensed that it was time for a policy switch. The financial-reform bill that had passed in the House in early December included an amendment from Paul Kanjorski, a Pennsylvania Democrat, giving the Fed the power to order individual banks to cease certain activities, including proprietary trading, if they were taking too many risks. Adopting Volcker’s proposal would go much further than that, and it would also serve an important political purpose. “We decided there was a way to do it that was O.K. policy and which had a bunch of tactical advantages,” the senior Administration official told me. “It would allow Volcker to align himself more fully with us. Because he was a little separate, people could project all sorts of things onto him. . . . They thought he was for all sorts of stuff he never was. That was damaging for the President, and it just wasn’t good strategy for us.”

On January 21, 2010, President Obama, with Volcker towering over his right shoulder in the White House’s Diplomatic Reception Room, urged Congress to enact “a simple and common-sense reform, which we’re calling the Volcker rule—after this tall guy behind me.” Volcker smiled and looked sheepish. The term hadn’t been in the speech draft that the White House had forwarded to Volcker’s office the previous night. David Axelrod, the President’s political adviser, had inserted it at the last minute, framing it with some populist language about the “army of industry lobbyists” that was fighting reform. “The Volcker rule” immediately entered the political lexicon, thus associating the White House with a figure known for his independence and integrity. “The other advantage of it,” Volcker joked to an associate, “is that if it doesn’t fly they can throw me under the bus.”

In February, the financial debate moved to the Senate, where two factors gave the reformers some momentum. One was Volcker himself. As chairman of the Fed, during the early nineteen-eighties he forced the prime rate to more than twenty per cent, bringing about a deep recession. Angry farmers blockaded the Fed with their tractors. Congressmen called for him to resign, and the Reagan White House urged him to cut rates. Until price increases came down, he did neither. He conquered inflation and, after the subprime crisis destroyed Alan Greenspan’s reputation, Volcker was left in the role of the nation’s senior financial authority.

“He’s a respected voice,” Jeff Merkley, who serves on the Senate Banking Committee, said last month. “That comes from his experience inside the system, but also his independence. . . . He wants to see a financial system that will have a robust foundation, and he wants to put the life experience he had to work in that effort.” Merkley went on, “You have Goldman Sachs and others hiring legions of lobbyists to come down here and spin the story so they can keep on doing business as usual. People were asking, ‘How valid is the stuff we are hearing from the big banks on Wall Street?’ . . . We needed that type of honest broker, and Volcker filled that role. He would say, ‘No, the banks are wrong about that.’ ”

The second key development that helped Merkley and other Democrats was the passage of health-care reform, in March, which meant that the issues of bailouts and bonuses returned to the headlines and the public began to clamor again for tougher regulation. On Capitol Hill, delays in passing bills often give lobbyists the opportunity to gut them. This time, though, the longer the debate about financial reform continued, the stronger the Senate bill became. “There is this narrative going around that big money runs everything,” Barney Frank said to me. “But public opinion will defeat big money. Last year, when we debated the bill in the House, there was no public opinion for us to rally. . . . When the Senate did the bill, there was no more health care as an issue, and public opinion came to bear.”

In March, Volcker threw his support behind Merkley and Carl Levin, who had formulated a more explicit statement of the Volcker rule than the somewhat vague language in the bill that Dodd was proposing. Anthony Dowd worked closely with the staffs of Merkley and Levin, making sure that their amendment didn’t contain any loopholes. Volcker also joined with the Treasury and the Democratic leadership to head off some more far-reaching proposals. After Senator Blanche Lincoln, a Democrat from Arkansas, put forward an amendment that would force the big banks to move their derivatives-trading desks into separate subsidiaries backed by more capital, Volcker wrote a letter to Dodd saying that such a move was unnecessary, providing that the Merkley-Levin amendment was enacted. And, when the Democratic senators Sherrod Brown, of Ohio, and Ted Kaufman, of Delaware, called for size limits that would have forced many big banks to split up, Volcker made it known that he didn’t favor going that far. “I’m not a barn burner,” he said to me. In May, the Brown-Kaufman amendment was put to a vote and was roundly defeated.

By late May, the Merkley-Levin amendment appeared to have gained the support of Dodd and other Democrats, and even some Republicans. In the House, the entire Republican delegation had voted against the financial-reform bill, which it portrayed, somewhat misleadingly, as a device to perpetuate bailouts. Mitch McConnell, the Republican leader in the Senate, took a similar approach. But the decision in the White House to back Volcker’s efforts to limit the financial safety net helped to win over some moderate Republicans, including Susan Collins and Olympia Snowe, both of Maine.

Before the full Senate could vote on the Volcker rule, however, the Republican leadership sneaked it out. Senator Sam Brownback, of Kansas, withdrew an amendment he had proposed, to which the Merkley-Levin measure had been appended. The strict version of the Volcker rule disappeared from the bill, which the full Senate passed later the same day. “It got outmaneuvered,” Volcker said. “I don’t know all how it happened.” Merkley put the responsibility squarely on the Republican leaders who, he said, wanted to protect the big banks without having the record of having voted for such protection.

In early June, as Congress prepared to start work on reconciling the House and the Senate bills, Volcker went to Barcelona for the annual meeting of the Bilderberg Group, an élite organization of financiers, politicians, and journalists. After he returned to New York, he told me that his aim was to resurrect the Merkley-Levin amendment and make sure it was included in the final legislation. “It will take a lot of parliamentary maneuvering, but, if people really want to do it, it can be done,” he said. The next morning, Volcker was leaving for Washington for the second time in a week, having postponed a vacation in order to monitor the House and Senate negotiations. “I don’t trust those guys down there,” he said with a guffaw, his long legs poking out from the bottom of his desk. “I am feeling reasonably good about where we are, but I’ve never trusted the Congress—what comes out of the sausage factory at the last minute. There are conflicting interests. People are going to try to amend it up and down and sideways. I don’t want them to amend it to the point of ineffectiveness.”

Volcker and his associates also suspected that some Administration officials were willing to make too many concessions to Wall Street, including on the Volcker rule. “I know the President, and I heard him say in a group that this is an essential part of the bill,” Volcker told me. “I think some other members of the Administration may be somewhat less enthusiastic about it.” While we were talking, an assistant came into Volcker’s office and said that Timothy Geithner was on the line. I went outside into the hallway so that Volcker could take the call. About ten minutes later, he came to the door. “We are in total agreement,” he announced, with a smile that suggested that that might not be the whole truth.

Last week, having had time to dwell on the unhappy developments of June 24th and 25th, Volcker was somewhat more upbeat. “We are much better off with it,” he said of the final bill. “It does show leadership in the United States, which will help encourage actions abroad. Without the U.S. stepping up, you’d never get a coherent response.” He pointed out that the language banning proprietary trading was strong and that even the much weaker language on hedge funds and private-equity funds still contained some safeguards that would force big banks to change how they do business. He also cited the crackdown on derivatives trading and a clause, which he had campaigned for, that creates a position for a second vice-chairman of the Fed, who will be explicitly responsible to Congress for financial regulation. “I think that might turn out to be one of the most important things in there,” he said. “It focusses the responsibility on one person.”

Anthony Dowd added, “We both felt like we got kind of excluded at the very end. But, when you step back, there were fifty-four lobbying firms and three hundred million dollars spent against us. So we didn’t do too badly.”

Yet a larger question remains: Will the reform package be sufficient to prevent future bailouts? Among economists, there is considerable skepticism about the Volcker rule. “If you have the incentive to take risks, there are so many ways that you can do it, and banning one specific activity is not very useful,” Raghuram Rajan said. “If I am a bank and I want to load up on risk, I can give loans to walking wrecks, and that will give me all the risk I want.” In fact, prohibiting banks from proprietary trading could “give you false confidence that they are not taking risks when they are.”

Volcker has pointed out that professional economists didn’t do a very good job of predicting the most recent crisis. The Volcker rule was intended not as a substitute for broader reform but as a supplement to it, and as a way of grasping the too-big-to-fail problem. If the stricter version contained in the Merkley-Levin amendment had survived, Goldman Sachs and Morgan Stanley, the last two big Wall Street firms, would probably have given up their banking licenses in order to protect their lucrative trading operations. In his mind, Volcker would have succeeded in re-creating a strict dividing line between those institutions which can rely on a government safety net (the biggest commercial banks) and those which can’t (all other big financial firms). The weaker version of the Volcker rule that was passed into law leaves many things, as Volcker says, “in a holding pattern.” Goldman Sachs and Morgan Stanley appear determined to retain their current status and to try to squeeze as much proprietary trading and hedge-fund sponsorship as they can under the new rules. The big commercial banks, such as JPMorgan Chase, could well hold on to their in-house hedge funds and private-equity funds, albeit with smaller ownership stakes.

Volcker may have won the intellectual debate, but, as he readily concedes, the practical challenge lies ahead. Two years from now, when the Volcker rule goes into effect, some firms may well try to skirt it, by, for example, placing big proprietary bets and trying to define them as something else. Without the legislative purity that Volcker was hoping for, enforcing his rule will be difficult, and will rely on many of the same regulators who did such a poor job the last time around, particularly those at the Fed. If the Obama Administration had been able to force the banks to hold a lot more capital in perpetuity, this would not matter very much: a financial system with low leverage can survive the occasional implosion. But international negotiations on a new set of capital requirements are going slowly, and there is no assurance that they will yield meaningful results. If they don’t, once the next credit boom gets going, leverage ratios will start rising again.

In this area, as in many others, the Dodd-Frank Bill is at most a useful beginning. As Volcker told me, it doesn’t really deal with a number of issues that contributed to the crisis, such as extravagant Wall Street compensation practices, misleading accounting, and incompetent credit rating. Ultimately, it also leaves open the question of what would happen if one of the biggest financial firms got into the same sort of trouble that brought down Bear Stearns and A.I.G. As a legal matter, the federal government could now euthanize such a firm instead of bailing it out. But is the threat of closure credible? If in five years Goldman, say, were to suffer a catastrophic trading loss, then, regardless of whether it had given up its banking license, the Treasury and the Fed would come under great pressure to save the firm.

Volcker says that the temptation to launch another bailout could be resisted. “I would say we are not going to do it,” he said simply—and, doubtless, if he held authority, he wouldn’t. In reality, though, the challenge of confronting the next Bear or A.I.G. will fall on less independently minded men, and, despite the passage of the Dodd-Frank Bill, it might not be very long delayed. “I do not think that anybody can tell me that there is not going to be another financial blowup of some kind,” Volcker said. “I hope we don’t have another big one—at least in my lifetime.” ♦

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